Fund Managers See Another Chance to Get Emerging-Market Bets Right

The Federal Reserve has given emerging-market investors an unusual reprieve: the chance to prepare for tapering that they didn’t get the first time around.

They are sitting pretty for the first time in months after the Fed unexpectedly elected Wednesday to stay the course on its easy-money policies. The asset managers that target emerging economies find themselves with plenty of cash on hand and an opportunity to position their funds for the day when the Fed actually does start to taper its stimulus program.

“The Fed decision has just bought us time,” said Denise Simon, portfolio manager at Lazard Asset Management. “It gives us time to reassess and look at countries again, and see what the underlying picture is.”

News of the Fed’s inaction provided an immediate boost to the emerging-market assets that fell out of favor after Fed Chairman Ben Bernanke told investors in May that the U.S. central bank could begin to cut off stimulus this year. Market participants were caught off guard by Mr. Bernanke back in May, as they had expected the U.S. to continue with the easy-money policies that have funded their quest for higher yields from riskier bets.

Many fund managers got caught in a selloff as they tried to rid themselves of high-yielding but potentially risky assets they no longer wanted.

For instance, Mongolia last November sold $1.5 billion in debt, with its 10-year part selling at a yield of 5.125%. That yield has gone up to 7.16%. Bond yields move inversely to prices.

This time, emerging market investors say they will be better prepared. They plan to stock their portfolios with equities, bonds and currencies of countries that have sound economic and fiscal books.

“We are coming up with a new hypothesis that there will be more differentiation among emerging-market currencies that is dictated by value and country strength,” said Alessio de Longis, portfolio manager of the $47.1 million Oppenheimer Currency Opportunities Fund.

He expects that currencies such as the Mexican peso and the Polish zloty will reach their pre-taper levels by year end. The Indian rupee and the Turkish lira may stall after their initial rally this week because of high inflation and large current-account deficits in those countries.

But Mr. de Longis said he plans to wait a while before he puts on his bets.

“We want to see the dust settle … and signs of [our] hypothesis coming true,” he said.

Such caution prompted many fund managers to stay on the sidelines after the Fed’s announcement this week, even with the market in a tizzy and nearly a dozen new bond issues in the works from emerging-market countries and companies.

“We are going to be very picky in the primary (new) issue market,” said Pierre-Yves Bareau, head of emerging-market debt at J.P. Morgan Asset Management, which manages $35 billion in emerging-market debt. “We are not in a big rush.”

Mr. Bareau said that even before the Fed decision, he had started to increase his holdings of local bonds issued by countries such as Mexico and South Africa, which he likes because they offer high yields, and adding dollar-denominated bonds issued by the governments of Indonesia and Brazil, where he expects yields to rally.

The caution by some emerging-market investors comes despite indications that many portfolio managers were holding more cash than usual before the Fed statement, a result of the selloff over the past several months. Morgan Stanley analysts estimated that emerging-market funds held 9% of their assets under management in cash as of July 30, more than double pre-taper levels.